Fundraising and the art of the seed round

Let's get this out of the way: Fundraising is only a part of a much larger process. While it provides some short-term validation and buzz, it does not guarantee actual success. The value of a startup at its Seed or Series A stage is largely irrelevant if it cannot build something meaningful that someone will eventually pay for. For that, customers need to be listened to, the product needs to be improved upon and the company needs access to expertise, resources and meaningful capital.

As usual, though this article is focused on the Bangladeshi startup ecosystem, much of it is relevant to companies and founders all around the world.

Here's what will be covered:

• What are the goals of fundraising?
• Is it absolutely necessary to fundraise?
• Different types of capital
• How does a venture capital fund work?
• How do institutional investors add value?
• How do institutional funds differ from angels or corporate investors?
• How should you structure your Seed round?
• Should you include angels in your Seed round?
• The importance of institutional investors
• Quality of capital matters—valuation does not
• Quick caveats on raising your Seed round
• Raise when you don't need money
• Is there a capital shortage for Bangladeshi startups?

What are the goals of fundraising?

On the surface, fundraising is about getting capital to grow your business. In practice, it's much, much more:

• Getting access to global resources
• Getting access to domain experts
• Getting access to more capital 
• Putting your company in a stronger position vs. competitors

Is it absolutely necessary to fundraise?

In short: No. Companies can be financially sustainable via three key methods:

1. By having positive cashflow to grow organically
2. By receiving grants and donor funding (as is common with NGOs and social enterprises)
3. By raising external funding, either via equity or debt, to fuel growth and competitiveness

It entirely depends on the founders and the type of business. Certain businesses with low overhead and operational costs do not need to fundraise in order to grow steadily. They may choose to fundraise if they want to accelerate growth or expand their business further. This is especially common for product-driven SaaS (software-as-a-service). 

By nature, many startups tend to solve complex problems requiring significant amounts of capital to get started. For such companies, investors with risk-tolerant capital are required.

What is risk-tolerant capital and how does it differ?

Different types of capital

Below is a risk vs. reward assessment of different types of capital. The term "risk-tolerant" indicates capital that is on the farther right side of this chart. Accordingly, these types of capital (especially venture capital) require a very high rate of return to justify the risk it undertakes.

Think of it this way: If you have $100, you may be willing to lose $1 if that $1 has the chance to return you $10. However, you wouldn't do that with $50 or even $20 of the $100.  

Most investors typically allocate their money into a blend of bonds, real estate and mutual funds/equities, keeping only a small amount to allocate to venture capital.

How does a venture capital fund work?

When wealthy individuals, families or organizations (such as pension funds, sovereign funds or endowments) want to invest in venture capital, they will usually allocate their money to an "institutional" venture capital fund. What does this mean?

Institutional venture capital funds (such as Anchorless Bangladesh) are professionally managed funds that invest on behalf of external investors in return for a management and performance fee. In other words, fund managers only get paid if their investors make money. Typically, a venture capital fund takes 2% management fee plus a 20% performance fee. While the actual math can be a bit more complicated, it basically means if someone is running a $10 million fund, they can take $200,000 in management fee every year to run the fund. In addition, if the portfolio returns a value of $50 million, then the fund takes a 20% performance fee, or in this case, $8 million (20% of $50 million minus the initial $10 million).

How do institutional investors add value?

The #1 priority for institutional funds is providing a return to their investors. In order to achieve this, these funds are often structured to support founders in various ways:

• Funds will typically reserve around 50% of their capital for follow-on investments into existing portfolio companies. This is critical for founders. If Fund X decides to invest in Company A, and Company A successfully scales the business and achieves its ideal metrics, it's possible Company A will want to raise more money for further growth. At that point it can ask its institutional investors for additional capital. In most cases, such investors will double or even triple down on their investment. That means the startup does not have to bring in all new investors into the round; they get a headstart with their existing investors already agreeing to a lot of it.
• Funds will help their startups raise capital. This can include everything from introductions to other investors to even asking the fund's even larger investors to come and support the portfolio companies on a co-investment basis. This is especially key as an institutional fund can share its existing due diligence materials and be a reference check for companies to speed up the fundraising process.
• Funds often have additional in-house resources to allocate to founders. For instance, Andreessen Horowitz is widely known for helping startups hire good talent.  Other resources include in-house CFO services and access to global mentors with expertise in specific fields.
• Funds will often use their networks to help founders do business development per the founders' needs.

How do institutional funds differ from angels or corporate investors?

Angels are individual investors who often manage their own personal portfolios in addition to their day job. Then there are some "super" angels who make a living out of it, especially when they've had a couple of big success stories. The quality of angels can vary quite a bit depending on experience and know-how. However, the key difference between an angel and an institutional fund is the fund has a fiduciary duty to continue supporting companies in the portfolio on behalf of their investors as long as it makes sense on a return basis. Angels, if they wish, can walk away at any time. This is why it's important that founders and angels understand each other well before they commit to each other.

Corporate venture capital is generally investment that's done off of a company's balance sheet. While strategic corporate investment can be valuable to a company's success (especially in later stages), it comes with one major caveat: If the corporate investor changes its business strategy and/or management, it's possible the investment will no longer be looked upon as a priority.

In both of these cases, institutional funds are, again, mandated to support their investments financially (using their reserve capital) and via additional resources (such as hiring and business development), whereas angels and corporate venture investors are not. This is especially relevant when you realize venture capital fund managers don't get paid unless the fund does well!

How should you structure your Seed round?

Once you understand 1) where in the risk vs. reward scale startups and venture capital are, and 2) how institutional venture funds, angels and corporate venture differ, it's easier to construct an ideal Seed round.

The goal for every startup for its Seed should be to have an institutional venture capital fund lead. What does a lead do?

• It runs due diligence on the company to confirm the business is real and the personnel are qualified
• It sets a valuation for the round
• It prepares relevant legal documents for the deal
• Most importantly, it gives confidence to other investors who want to participate in the deal along with them

If you want to know which funds tend to lead, you can check out Crunchbase. For instance, Wavemaker Partners (who most recently led a round for Shikho) has led 116 of their 507 investments:

Information on funds and deals is often publicly available on sites like Crunchbase. Every startup founder needs to be familiar with it.

In addition to a lead institutional investor, it's preferable to have another one or two institutional funds participate, meaning they write a smaller check along with the lead with hopes that they can possibly participate or even lead the round after. Incidentally, before Wavemaker Partners led Shikho's latest round, they previously participated in the previous round (which was co-led by Anchorless Bangladesh and Learn Capital).

Should you include angels in your Seed round?

Absolutely! However, it is critical to make sure they can add value to your company. Ultimately, you want folks on your cap table (or shareholding structure) who you want to work with for 5+ years, who can add value to the specific work that you're doing and who you see eye to eye with. In Shikho's Seed round, the startup had a strategic angel investor in Ankur Nagpal who previously had sold an edtech startup for US$250 million. Ankur not only brought domain knowledge to Shikho but also went on to participate again, this time through his own fund Vibe Capital, into the next round.

The importance of institutional investors

This is worth repeating: Institutional investors typically are mandated to support startups through multiple rounds because fund managers do not get paid unless portfolio companies are successful. This becomes even more relevant when a startup goes to raise another round.

For instance, Shikho closed US$1.3 million in funding in July 2021 and then another US$4 million in March 2022—and every investor from the first round participated in an even larger size in the second round. In fact, existing investors wanted to fund nearly the whole round, meaning the founders at Shikho didn't have to start their fundraising from square one. Instead, they could go to the market having the confidence that their existing investors were supporting them. This gave a strong signal to incoming investors and made Shahir and Zeeshan's ability to raise capital much, much easier—and the round ended up being oversubscribed to the point where the founders could decide who they wanted and how they wanted to allocate.

The best Bangladeshi example of what happens when you have strong institutional investors backing you may be ShopUp:

Omidyar Network, who led the initial Seed round in 2018, came back in 2020 to invest in Series A (under Flourish Ventures, a spin-off from Omidyar Network focused on impact fintech) alongside Sequoia India, which runs the Surge accelerator. This means Afeef and the team at ShopUp had support on day one from two key investors that then helped them raise a subsequent US$174 million!

Realistically, investors don't want founders to just fundraise—they want them to spend their time running the company! So, the more an investor can help a company close rounds of capital, the better it is for both parties.

Quality of capital matters—valuation does not

Not all money is the same. As a founder, if you're looking to give up 20% of your company in a round, you want to make sure the money you bring in has long-term value. It's best to have a blend of investors whom you believe can be meaningful to your company's goal, including institutional investors and strategic angels. Remember that the earliest investors will often be the most incentivized to see you succeed (as their valuations will likely be the lowest). So, you want to take your time and find investors who you want to get into a relationship with.

Unfortunately, many founders overestimate the valuation of a company too early. What really matters is the value of a founder's equity over multiple rounds, over a longer period of time. Below is a hypothetical comparison between two companies that bring in high-quality investors at a lower valuation vs. random investors at a higher valuation: 

What is most important to remember here is that the jump from Seed to A and A to B is the hardest because it requires the company to break through significant market barriers in scaling and access. This is where high-quality investors matter the most.

The key takeaway is that incentivizing high-quality investors to fight for the company can pay off in the longer term. Remember, just because someone "values" you at $5 million doesn't mean you can actually sell the company for that much. The valuation takes into effect future value, most of which you may not have even created or built yet… and in order for you to realize that value, you will need investors who can help you get there.

Quick caveats on raising your Seed round

• Expect to speak to a lot of investors. Because of this, your initial filtering process should target mostly institutional VCs who are likely to lead your round. Here is a fundraising funnel template to assist you.
• Understand mandates. An Indian fund that's been told by its investors to only invest in India is likely not going to invest in Bangladesh even if they're "close by." A U.S. fund that has a global strategy just might, however.
• Get warm introductions. VCs get tons of pitches every week. It's best to stand out by getting a referral from someone they trust so you stand out.
• It takes longer than you think. Expect 6 months minimum and up to 9-12 months. Even after receiving a term sheet, there's usually additional due diligence and followed by period where parties have to agree to the deal and legal terms.
• Give yourself a window to make a decision. You can always "get a better deal" theoretically, but it may come at the expense of your company's ability to keep momentum. Or it may never come—which many, especially in the SaaS space—have just experienced with the recent economic downturn.
• Be honest with yourself. It's easy to blame others for shortfalls in fundraising, but the truth is nobody is entitled to capital. There must be an agreement between two parties, each with separate ideologies and interests, in order to make a deal happen. It's important to note where the disconnects are, including where the founders/startups have shortfalls. On that note, I suggest reading this self-reflective piece by Airwrk Co-Founder & CEO Sayem Faruk on what he's learned so far.

Raise when you don't need money

One of the most common mistakes founders make is waiting too late to raise capital. When a startup has little runway, they lose their ability to negotiate on terms. However, when a startup has the cash, it can comfortably go into an investor pitch and say, "We're comfortable for 18 months. However, we'd like to strengthen our position and are raising X amount." Not only does that send a signal to investors that the founders are thinking ahead, it also excites them that they can be part of a successful journey.

Is there a capital shortage for Bangladeshi startups?

The answer is simple: No. In fact, there is more interest to invest in Bangladeshi startups than there has ever been.

Bangladesh continues to be a vast, growing consumption powerhouse of 170 million people, including 35 million in the middle and rising middle class. With valuations being regionally low, startups that solve for this market should have little problem attracting capital. The key remains for founders to focus on institutional rounds so that capital for future growth is more readily available.

A disciplined, clinical fundraising strategy combined with a qualified, experienced founding team and a visible, executable go-to-market strategy are the cornerstones of closing a proper Seed round that sets up a startup for long-term success.

The author is the Founding Partner & CEO of Anchorless Bangladesh